Executive Panel: India-Economy and Markets 2019

Moderator: Nikunj Dalmia, Managing Editor, ET NOW

Written by: Ishwar Chidambaram, CFA, FRM, CAIA

Delegates at the Ninth India Investment Conference (IIC19) 2019 had access to a distinguished panel. The subject was the outlook for Indian economy and Markets in 2019. The speakers included Navneet Munot, CFA, CIO, SBI Funds Management Pvt. Ltd., Milind Sarwate. Founder and CEO, Increate Value Advisors LLP, Sunil Singhania, CFA, Founder, Abakkus Asset Management, LLP, Ridham Desai, Managing Director, Head of India Research, and Equity Strategist for India at Morgan Stanley, Research Division, and Sajid Chinoy, Economist (Asia), JP Morgan. The moderator was Nikunj Dalmia, Managing Editor, ET Now, who enlivened the discussion by bringing the best out of the panelists.

The discussion began on a lighthearted note, but quickly took on serious tones as the panelists spoke about the year gone by. There was unanimous consensus that 2018 was a bad year for most asset classes (except gold), which have all generated negative returns.

Sunil opined that investors must remain optimistic and as long as India keeps growing the returns will follow. He said that the next two years will be the period when Value stocks outperform. Mutual funds are still in a nascent phase in India and are under-invested in the firms that will be future leaders of the markets. On themes for the next 1 to 3 years, he is bullish on Discretionary Consumption, and Beverages are his favorite sector. He is also bullish on utilities which are expected to return 15% annually.

Milind suggested that the rural sector is leading urban sector in consumption. News flows will reach a crescendo in the election year. On sectors, he is not very bullish on Pharma as it is not a great consumer play. In 2019, he expects the following factors to attract investors to consumer stocks- namely they are defensive, rural consumer demand will peak and digital revolution, which has ensured that the cost of creating a new brand has fallen sharply. He is bullish on firms like HUL, Dabur and smaller FMCG firms and retail plays. He expects proximity to the consumer to be important going forward.

Ridham reminded the audience that markets have long cycles. Legendary investor Howard Marks made only 6 active calls in 50 years! In India’s case, there were shocks to the system like demonetization and GST. In 2018, India witnessed the longest and deepest earnings draw-down in our nation’s history. He is sure there will be another panic in the stock markets, but feels that we are in an up-cycle. Growth will be the source of market returns. Elections are only a short term factor. Specifically, he emphasized the importance of Growth At Reasonable Price (GARP) strategy, saying that it is not good to overpay for growth. He does not prefer the term “Value”, as people often confuse it for “Multiples”. He prefers GARP.

Sajid feels that crude prices explain India’s growth very well. Right now we are witnessing a positive terms of trade impulse from crude. The monetary conditions index is at a 2-year low. Policy reforms like asset reconstruction, IBC, etc. are starting to bear fruit. He is however apprehensive that monetary, fiscal and regulatory easing combined will push India over the edge, which could prove dangerous in 2019. He is also worried about the increased indebtedness of the Indian states, whose deficit is bloated. The underlying current account deficit has also worsened. He asserted that there is no fiscal space for populism and that some amount of rupee depreciation is a good thing.

Navneet said that with the fall in crude prices, India’s macroeconomic situation is better in 2019. There has been a tight monetary policy in terms of real rates. As GST compliance increases, fiscal situation will improve. Earnings have been below nominal GDP growth since 5-6 years. He expects decent returns over the next year, but markets will be very volatile. He prefers multi-cap funds, and feels that India is a stock picker’s paradise. There are many sectors where the largest companies are mid-caps or small-caps, and therefore have tremendous potential. Companies that are small and agile should trade at a premium versus large and slow companies. Corporates have deleveraged their balance sheets. He prefers Capital Goods, Engineering and Construction.

  • IC
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Behavioural Biases and Pitfalls: Stories on How Investors Go Astray and How to Overcome Them

Speaker: Morgan Housel, Partner, Collaborative Fund

Moderator: Kalpen Parekh, President, DSP Investment Managers, Pvt. Ltd.

Written by: Ishwar Chidambaram, CFA, FRM, CAIA

Morgan Housel- Partner, Collaborative Fund- gave an amazing presentation on behavioural biases and pitfalls faced by ordinary investors. This was the most eagerly anticipated session of the conference and it lived up to its billing. Morgan began by asserting that we all have vastly different experiences as investors.  He gave the example of 2 investors in the US, one of whom (“Grace”) was from humble background but earned millions through successful investing. The other (“Richard”) enjoyed a privileged upbringing but was forced to declare bankruptcy. Thus one can conclude that investing is not about what you know, rather it is about how you behave!

Morgan’s presentation revolved around 5 stories which reinforced his central theme:

Story 1: Nuclear Energy and Investing- Austrian citizens chose not to turn on a US $ 1 Billion nuclear power plant due to safety considerations. This was despite the fact that other nations like US, UK, Japan, etc. were all using nuclear power safely. Thus risk is not universally perceived the same way by all investors. Morgan gave the additional example of US and Australia. He said that Australia has had no recession in past 27 years, while US has witnessed 3 recession in the same period. Thus these two nations hold diametrically opposite views on the risk of recession- while US tends to be paranoid about recession, Australia tends to be complacent about the same. Similarly, individual investors’ willingness to bear risk depends on their personal history. As Daniel Kahneman points out- we explain the past with ease, but we are terrible at predicting the future. There are 3 ways to overcome this:

  1. Talk to as many people as you can- This helps to broaden one’s horizons
  2. Talk to people you disagree with- This helps to avoid confirmation bias
  3. Talk to people in different emotional states- especially important for financial advisers to regard clients without emotion

Story 2: War on Cancer- Today cancer rates are falling as the war on cancer has been effective at saving lives. We may be unable to cure cancer completely, but we can prevent cancer by modifying diet, lifestyle, etc. However, it is very difficult to raise money for cancer prevention (as opposed to cancer research). This is despite the fact that the impact of cancer prevention is greater than that of cancer research, but the former is just not very intellectually stimulating. The same applies to investing, wherein simple rules for investing are not followed by most people, who are looking for complex theories. Morgan compared the desk of legendary investor Warren Buffett with that of a trader from Lehman Brothers (shortly before bankruptcy). The former desk is simple and clutter-free, while the latter appears chaotic and disorganized. Morgan also pointed out that Warren Buffett’s investment firm Berkshire Hathaway has outperformed Private Equity funds by 5.1% on average. This is largely because the latter charges a 2 and 20 fee structure, while Berkshire does not charge any fees. This accounts for at least 4% out of Berkshire’s 5.1% annual out-performance. Morgan revealed that the father of Modern Portfolio Theory, Harry Markowitz- who pioneered the use of complex concepts like Efficient Frontier- himself used a simple 50:50 rule to split his investments among stocks and bonds! Morgan concluded by asserting that the goal of investing is not to minimize boredom, it is to maximize returns! If you want clients to stick around, then do things simply.

Story 3: Development of Babies’ Brains- The numbers of synaptic connections formed among neurons in an infant’s brain are amazing. These reach a peak by the age of 2 years, and keep declining steadily thereafter. A lot of synaptic connections in new-borns is actually haywire. Babies can actually hear colours and smell sounds! They get smarter by getting rid of the chaos in their brains. This analogy can be extended to investing. Most investors buy out of greed near market peaks and sell out of fear near market bottoms, repeating this cycle until they are broke! As Eisenhower remarked, “The great leader, the genius in leadership, is the man who can do the average thing when everybody else is going crazy.” This applies to successful investing.

Story 4: Running- Archibald Hill was an English physiologist who attempted to answer the question “How fast can we run?”. He came up with exotic formulae to predict how fast a human being can run. In 1922, he was even awarded the Nobel Prize in Medicine for his efforts. The irony was that although his formulae were very accurate in the laboratory, they were of no practical significance on the racetrack. Thus they were of no use to predict future winners of actual races. Mr. Hill responded to his critics by saying that “We don’t do it because it’s useful, we do it because it’s amusing!” Mr. Hill and his team failed to account for the fact that how fast we can run is not just a function of bodies and muscle power, but also of psychology. Contestants in races get anxious, nervous, hyper-focused. This applies to predicting the financial markets as well. Every year since 2009, various financial publications have been screaming themselves hoarse saying “The easy money has been made!”. This has happened every year for the past 9 years, yet the bull run in stock markets has soldiered on. This is mainly because share prices are a function of 3 factors-

  • Dividend Yield – This is easy to calculate
  • Earnings Growth- This can be found
  • Change in Valuations- This is impossible to know as it captures people’s sentiments

This is where the Margin Of Safety comes in. As Ben Graham said: The function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future. Thus, while margin of safety gives an investor room for errors in forecasting, it does not imply conservatism.

Story 5: Wright Brothers and Investing- The invention of flight is today universally recognized as one of the most important developments of the 20th Century. However, the remarkable story of the Wright brothers quest to build a flying machine was not given any importance by the news media at the time. In fact, for nearly 2 years nobody paid any attention to this revolution in the making, except the Dayton Herald, which covered the story out of sympathy! The Wright brothers mastered the art of turning and landing the aircraft, thus demonstrating creativity and engineering ability, and ultimately pioneered the development of modern aviation. This story shows that important events which shape the future of humanity are often overlooked by news media.

The lesson from all the above stories is that stocks become less risky the longer one holds them (more than 10 years). Ultimately it is worth bearing in mind that people don’t get what they want or expect; they get what they deserve.

  • IC
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The Wisdom of Finance- Mihir Desai in Conversation with Paul Smith, CFA

Speaker: Mihir Desai, Mizuho Financial Group Professor of Finance, Harvard Business School; Professor of Law, Harvard Law School

Paul Smith, CFA, President and CEO, CFA Institute

Written by: Vivek Rathi, CFA

Prof. Desai tried to explain how finance is related to Humanity. His book “The Wisdom of Finance: Discovering Humanity in the World of Risk and Return” tries to connect two worlds which one thinks are not connected. He started by a quote from Wallace Stern “Money is kind of Poetry”  and followed it with a number of Pictures from history, each trying to communicate something important in contemporary world. Few key takeaways from his session:

  • Stories should be used to understand Finance
  • The world is random and not structured, there is randomness everywhere. Good part is, this randomness can be managed
  • Investors/managers generally face Principal-Agent problem
  • It is really hard to become principle
  • We do not punish people who fail
  • The gap between Finance and Humans is a real loss
  • Optimistic about India but expectations have to be rational
  • Indian companies should focus on Corporate Governance
  • Indian companies spend too much time on analyzing Policy makers/actions, instead corporates should focus on Innovation
  • VR


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Decision Making Under Uncertainty- Less Is More

Speaker: Gerd Gigerenzer, Director, Harding Center for Risk Literacy, Max Planck Institute for Human Development

Moderator: Madhu Veeraraghavan, Director and T.A. Pai Chair Professor of Finance, T.A. Pai Management Institute (TAPMI)

Written by: Chetan Shah, CFA, Director and Secretary, CFA Society India (IAIP), and Partner, 3 Jewels Investing

Most of the activities or events in the real world do not need complex formulae or algorithms to deal with them successfully. Take the example of Fly ball or cricket ball. In order to catch the ball, one can build in complex equations taking into consideration the angle of trajectory from the ground, force it has been hit with the bat, acceleration and later deceleration, and finally the spot where it will land. If the player were to do all those calculations in fraction of seconds will he be successful? Nope. Instead he is trained to run behind the ball keeping the angle of gaze constant, until the ball lands up in his hands.

Take another example of using simple heuristics. Chesley Burnet Sullenberger III (Sully) is a well known airline captain who landed US Airways Flight 1549 on the Hudson River off Manhattan after both the engines shut off as the plane was being hit by a flock of Canadian Geese shortly after take-off. All the 155 passengers on board survived. After the trials, the National Transportation Safety Board ruled that Sully made a correct decision in landing the plane on the river instead of attempting to return back to LaGuardia airport. Simulations performed at the Airbus Training Center Europe in Toulouse showed that the flight could have made it back to the airport had that maneuver begun immediately after the bird strike. However, such scenarios both neglected the time necessary for the pilots to understand and assess the situation, and risked the possibility of a crash within a densely populated area.

In both the above examples the intuitions of experts and the simple rules they followed helped them take faster and better decision. Such simple rules or heuristics are often been overlooked by the people. There are three widespread misconceptions about them viz. heuristics are always second-best to optimization based decision models, heuristics are unconscious and error prone, and complex problems require complex solutions. That happens because of failure to distinguish between “risk” and “uncertainty” and responses to deal with them. Professor Gerd Gigerenzer provided valuable insights in this area in a simple and humorous way.

The four key messages from Gerd were (1) “risk” is not “uncertainty”. This distinction is still not very well understood & appreciated by many academicians. When we talk about risks, perfect knowledge of the future states of the world, their consequences and probabilities are available. Whereas under uncertainty all the future states, consequences and probabilities cannot be foreseen. Hence the best decision under “risk” may not be the best decision under “uncertainty”. (2) For taking rational decision making under uncertainty, simple heuristics are helpful as they reduce error compared to complex models which over-fit the past data. To illustrate the same consider the last year’s data on London’s daily temperatures or levels of any financial market index. Professor showed curves fitting the past data drawn with polynomial equations having degrees ranging from 1 to 12 degrees. Which one of these fits this data better? Naturally, the one with more degrees. However, when it came to predicting future temperatures or levels that was not true. The one with 3 (and up to 7) degrees predicted better than the higher degree polynomials. Likewise the one with only one degree showed higher variance. Hence the phrase from Einstein “make it simple but not too simple”. One degree has high bias + moderate variance. Third degree polynomial too has high bias but low variance. Higher degree polynomials like 12 degrees lead to low bias but very high variance in predictions. So in the field of predictions under uncertainty, you need to scale things down. (3) Are Finance Theories useful? We need new financial models, which are simple and have better predictability. Optimization models used to manage risk only create illusions of safety. (4) Lastly, less is more. Simple heuristics decision model can be more effective than complex optimization models. For example, the Fast & Frugal Tree for assessing bank vulnerability and comprising of only few key variables like (a) leverage ratio (<4.1%?), (b) market-based capital ratio (<16.8%),  (c) Loan to deposit ratio (> 1.4%) is more likely to succeed. This is because (i) they are simple to explain to key stakeholders like management and investors and easier to monitor, (ii) the correct combination of indicators can be less prone to gaming by the industry and (iii) banks can be spared with all complex stress tests. Hence simple effective rules are better.

  • CGS



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India’s Economic Ambitions: Can the Financial Sector Deliver?

Speaker: Ratna Sahay– Deputy Director, Monetary and Capital Markets Department, International Monetary Fund

Moderator: Ajit Ranade, Group Executive President and Chief Economist, Aditya Birla Group

Written by: Ishwar Chidambaram, CFA, FRM, CAIA

Ratna Sahay- Deputy Director, Monetary and Capital Markets Department, International Monetary Fund- gave an engaging presentation on the role of the Financial Sector in realizing India’s economic ambitions. She began by informing that every 5 years the IMF reviews the financial sectors of all the major nations globally. India is consistently at the top, as compared to the likes of Brazil, Russia, China, etc. with respect to GDP growth rate. This growth has been inclusive and there has been an overall decline in poverty. Comparing 2010-13 with 2014-17, India’s deficit has actually fallen. Moreover India has adopted a flexible inflation targeting approach, which has looked at different measures of inflation. On the flip side, India is one of the few nations where the State dominates the banking sector. This is bad, as it is desirable to have competition in this sector. India also suffers from having a lower number of transactions in banking sector, as compared to the US. Further, the spread between the lending and deposit rates in India is very high, which indicates lower efficiency in the financial sector.

The speaker then provided a number of measures of financial debt for India. She said that in most of these, India is comparable with the US, except for the Pension markets- where India is very small by comparison. Also domestic credit to private sector (as percentage of GDP) is less in India compared with Developed Markets (DMs). This could be because the Public Sector Banks (PSBs) are in deleveraging phase. She then proceeded to ask the important question of whether there is a limit to finance that is best for a country. She informed that the IMF has answered this by constructing a financial development index comprising 128 nations. They used regression analysis to see whether there is an inflection point. The results show that beyond a certain point, growth in financial sector can be detrimental. Many DMs have too much finance, while Emerging Markets (EMs) have scope for growth. She added that there exists a trade off between financial sector development and financial stability. One third of the IMF’s regulatory principles are very essential for financial stability. There is no trade off for regulation and supervision.

Growth must be inclusive to sustain. If the gap between rich and poor widens then good policies start getting reversed. In India’s case, the implementation and growth of Aadhaar has brought a greater share of the population into the financial system. Subsidies can now be brought into beneficiaries’ accounts directly without any middlemen. There is also a gender gap in access to financial services, with men having more access to finance than women. In India this gender gap has narrowed considerably from 2011 till today. There is generally no trade off between financial inclusion and financial stability, as it is always better to bring maximum people into the financial sector for transactions, subsidies, etc. However, the exception to this rule is that if credit is extended beyond a certain limit, then it will hurt financial stability. If there exists high quality of regulation and supervision, then credit can be extended without any threat of financial crisis. In case of poor regulation and supervision, there can be a deterioration in banks’ credit quality with rising levels of credit. In India, PSBs are doing poorly, hence they are unable to extend credit to the economy. PSBs poor performance is reflected in their dismal ROAs, CARs and NPLs. The Non-Banking Finance (NBF) sector is actually doing better than PSBs, at least from the CAR perspective. The problem facing NBFCs is that of maturity mismatches. There have been a number of excellent reforms like IBC, PCA, Recapitalization of PSBs, etc.

For next steps, the IMF feels that RBI should get full regulatory and supervisory powers over the PSBs. IBC should provide for out of court, flexible ways to do restructuring. PSBs need to be restructured or privatized. Weak banks need to be shut down. Authorities should improve their crisis preparedness.

  • IC


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Incorporating Geopolitical Analysis into your Investment Process

Speaker: Matt Gertken, Vice President, Geopolitical Strategy, BCA Research Inc.

Moderator: Ananth Narayan, Associate Professor, Finance, S.P. Jain Institute of Management and Research

Written by: Vivek Rathi, CFA

Matt Gertken spoke in details about geopolitical situation globally. He delved in to history, explaining how move to the right in 1990’s created inequality and the resultant backlash in UK & USA. Then, he went to explain the poll arithmetic and how pundits generally get it wrong but the polls aren’t that bad.

He also explained, why politicians react the way they do, as they are driven by constraints and not by preferences.  According to him, a recession makes it significantly challenging for an incumbent president to win back the mandate. In fact, structural reform may lead to set back for ruling dispensation but will be beneficial for the economy in long run.

On the future outlook, the key take away were: Fed is expected to hike interest rates, there will be patches of corrections stock Market, don’t expect trade wars to be resolved any time soon, Oil prices will rise and China may try to stimulate economy without success, developing markets will continue to perform better & due to rising trade dispute, consumer oriented economy like India are expected to outperform. Also, India is slowly de-leveraging which is a positive sign. The cleaning up of banks, formalization of taxation and markets is credit positive for India.

On the US China trade war, though, the recent correction in US markets would have prompted Trump to soften position on trade dispute but the US is more insular economy, thus less depended on trade. In contrast, China is slowly becoming insular but is still vulnerable.

  • VR


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Hedging – Indian stock market context

Contributed by: Meera Siva, CFA

PR Sundar is not a conventional speaker and a standard blog will not do. At the CFA Society Chennai Chapter’s speaker event on January 4, 2019 (GRT Grand Hotel), he spoke on option strategies. While the topic tends to be often Greek, he simplified with analogies, examples and peppered it with a lively humour and stats (did you know that the South Korea’s index is the most traded index option contract in the world?) which kept the packed crowd (44, with a few coming from out of town to attend) completely engaged. Sample this. He asked what a hedge was; then searched Google; it showed pictures of plants – hedges which act as fences to protect.

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As a TV celebrity trader who is well covered in the print media and a strong social media following, PR Sundar needs no introduction. In a segment where professionals get wiped out, he is clocking gains year after year. A maths teacher in his early years and coming from a rural background, he is self-taught; his knowledge and success are thanks to his passion and poise.

The trader

As strategies must gel with the nature of the person implementing it, he took nearly a third of his 100-minute talk to share his background. It helped the listeners evaluate if a strategy would be suitable for them or not.
For example, he explained how he had little or no knowledge of the stock market and briefly subscribed to IPOs as a low risk strategy (pre Harshad Mehta days). And got back to the market quite by chance and how his value system has been built. He noted that people (through the example of his class-mate) do not take risks when they have the ability (capital, stable cashflow) but want to do it when they don’t (no income and limited savings).

Why sell options?

Sundar views selling options akin to selling insurance. There is a lot of mainstream media narrative that buying options is low risk and high reward while selling options has unlimited risk. He, however, uses option selling to enhance returns of a buy-and-hold investor’s portfolio. “Holding gives price-value to an investor while options give time-value gains”, says Sundar.

To illustrate, he shared returns of an investor’s portfolio of about INR 6.5 crores since late October 2018. Capital appreciation of the portfolio was about INR 65 lakhs in 2 months. On a hedged portfolio of INR 4.2 crores, option return was INR 73 lakhs in the same period.

The strategy is to have an underlying and selling options backed by it. The reason it works is that stock prices do not change in either direction very fast and stays around the same levels. So, selling options gives cashflow. For instance, if a stock trades at INR 900, you can sell call options for INR 1,000. If the stock does not move, call option sale gave you some return. If it moves by less than INR 100 before the option expired, there is call sale plus capital appreciation. If it crosses INR 1,000, you can deliver the stocks when the option is called; there is call sale gain plus the INR 100 from stock price increase.
For many stocks, there is no issue of liquidity. But if the volumes are low, it is best to use an index as a proxy (NIFTY or sector NIFTY).

Some strategies
Nightingale Strategy: Consider a stock at INR 1,100. Call options @ INR 1,200 may be priced at INR 10 and you can sell these. If prices shot up fast, to INR 1,200, you can offset it by buying 1,200 calls. They may be priced at INR 15 now. To fund this, sell options at 1,250. These may be priced at say INR 7.5, so you may have to sell twice as many as the 1,200 calls. You can keep repeating this strategy of doubling. You will not have the underlying to deliver as you go on this route and must manage your margin. The good thing is that the underlying’s price is increasing, giving you some cushion.

Collar strategies: A collar strategy involves selling calls at a higher price and buying puts at a price lower than current price of underlying. This limits the risk and return in a range (or collar), for no cost. In this, if the number of calls you sell is double that of the puts, there is a gain. Here again, if the market runs up, you can do the nightingale strategy to extend your runway.

Ratio spread: The idea of this strategy is to keep the upside (by taking some risk) while limiting the downside. If the market has support at say 10,000 levels, you can buy puts for 10,800 and sell double the quantity of 10,000 puts. The prices of these two may offset each other. If the market goes up, you capture the upside. If it does down, there would be losses and other strategies must be used to manage the situation (as the original assumption of support at 10,000 levels did not pan out).

There are many other strategies beyond this. For example, there are methods to deal with binary events such as the Parliament elections.

The talk gave a glimpse of how calls and puts, buying and selling, numbers and price, can be used based on the market view. Not just that, you must closely follow the action and tactically adjust your position based on the market movement – or changing the dance to the tune of the market, as Sundar says.


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